UK recovery the right kind for growth?

As growth forecasts for the remainder of the year increase from 0.8% to 1.5%, it looks as if the UK has turned a corner and on the road to economic recovery. But are we heading for the right kind of sustainable growth?

Fuelled by a credit and property boom, the crash of 2008 acted as a warning to re-balance the economy away from consumption towards investments and exports, but little has happened to address this. Instead consumption is driving the recovery, financed in part by reduced household savings.

Meanwhile the government’s Funding for Lending and Help to Buy schemes have stimulated the housing market by improving access to mortgages for first time buyers. However, in the long term is it sustainable to base hopes for the recover on the property sector?

Instead of making house prices more affordable for first time buyers, the schemes have the potential to inflate the market. As house prices rise, homeowners tend to spend more, inflating the size of the non-tradeable sector. As this sector grows, workers are sucked out of the tradeable sector. The difficulty is that innovation and technological growth are lower in the non-tradeable sector, so in effect the housing bubble encourages deindustrialisation and reduces the growth potential in the economy at large.

Bankers also rely heavily on property collateral. If the sector is not confident about the housing market, they extend less credit to businesses to finance an upturn. Since banks often require entrepreneurs to back their borrowing with housing collateral the small business sector also needs a rising housing market to prosper and generate jobs.

However, with the public sector contracting, the eurozone struggling and emerging market growth slowing down, one could ask, how else is a recovery going to start if not through increased consumption?

Since the manufacturing sector only accounts for 11% of GDP, perhaps there are limits as to what the sector could achieve, even if exports were better. Also, at this fledgling stage of the upturn, companies need more certainty about future demand before they commit to significant investment.

By way of a contrast, the German economy which has much lower home ownership and relies heavily on exports, has rebounded more strongly from the recession. But before we look enviously at their achievement, we should remember that Germany’s dependence on external demand has deprived their workers of what they have earned and should be able to save and spend. Some commentators also believe the country’s export ‘obsession’ has distracted policy makers from recapitalising the banks, deregulating the service sector and reallocating capital away from old industries into new technologies and future growth areas.